Getting Ready to Cover Their Real Estate Market Risks

With the price of homes rising so much over the past few years as interest rates fell to record lows, the popularity of real estate for investment and personal use has obviously risen. A new product from Standard & Poor’s will now make it easier for investors to bet on the future price of homes without buying them.

This month S&P is expected to officially launch indexes that track home prices in 10 major U.S. cities–Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Francisco, San Diego, and Washington, D.C. The indexes will be the basis for housing price futures and options contracts that are to start trading on the Chicago Mercantile Exchange on April 26.

If you can bet on the future prices of pork bellies, stocks, precious metals, lumber and more, why not be able to bet on the direction of U.S. home prices?

By being able to bet on the future direction of home prices, either up or down, U.S. builders now have a viable option to protect their businesses against a slowdown in demand. And it couldn’t have come at a better time.

With interest rates having risen aggressively in the U.S. since the summer of 2004, most analysts have come to the conclusion that housing prices have passed their peak in this current cycle. The big question for the real estate market: are we headed for a crash or a soft landing?

Hence, an option or futures contract that enables one to bet on the future price of U.S. homes could be coming out at just the right time for home builders, pension funds, construction companies, and even mortgage companies that all have a lot riding on the future direction of home prices. If you’re a builder with 1,000 homes under construction, and interest rates are rising aggressively, why not buy some insurance against a market collapse?

Option and futures contracts are not established unless there is a demand for them. And my understanding is that there has been huge interest in this type of product from market participants.

Personally, I think the establishment of an index that tracks the price movement of homes in different cities, and one you can bet on, ultimately tells us the people involved in the home building and home lending industries are worried. they want to start covering their risk. That’s fine for them because they can afford the insurance. But it certainly doesn’t give much comfort to the poor home buyer who cannot afford, or who does not trade, options and futures.